Mad Hedge Technology Letter
May 8, 2018
Fiat Lux
Featured Trade:
(BUFFETT GOES ALL IN WITH APPLE),
(SNAP), (WDC), (GOOGL), (AMZN),
(CRM), (RHT), (HPQ), (FB), (AAPL)
Posts
Not every stock comes with Warren Buffett's confession that he would like to own 100% of it. But, of course that stock would have to be a tech stock.
As it stands, the Oracle of Omaha owns 5% of Apple (AAPL), and his confession is still a bold statement for someone who seldom forays outside his comfort zone.
Buffett also continues to concede that he "missed" Google (GOOGL) and Amazon (AMZN).
What a revelation!
The outflow of superlatives invading the airwaves is indicative of the strength technology has assumed in the bull market.
The tech sector has been coping with obstacles such as higher interest rates, trade wars, data regulation, IP chaos, and the globalization backlash.
However, the tech companies have come through unscathed and hungry for more.
Their power is not contained to one industry, and techs' capabilities have been spilling over into other sectors digitizing legacy industries.
Every CEO is cognizant that enhancing a product means blending the right amount of tech to suit its needs.
It is not halcyon times in all of tech land either.
There have been some companies that have faltered or were naturally cannibalized by other tech companies that disrupt business.
Times are ruthless and this is just the beginning.
There will be winners and losers as with most other secular paradigm shifts.
Particularly, there are two types of losers that investors need to avoid like the plague.
The first is the prototypical tech company hawking legacy products such as Western Digital Corp. (WDC) that I have been banging on the table telling investors not to buy the stock.
The lion's share of revenue is still in the antiquated hard drive business that has a one-way ticket to obsolescence.
Yes, they are turning around product mixes to factor in its pivot to solid state drives (SSD), but they are late to the game and deservedly punished for it.
Compare WDC to companies that have completed the transition from legacy reliance to the cloud, and it is simple to understand that companies such as Microsoft, which struggled for years to turn around with CEO Satya Nadella, finally can claim victory.
The problem with WDC is the stock's price action performs miserably because the company is tagged as an ongoing turnaround story.
On the other hand, headliner cloud plays experience breathtaking gaps up due to the strength of the cloud such as Amazon (AMZN), Red Hat (RHT), and Salesforce (CRM), just to name a few.
To pour fuel on the fire, speculative reports citing NAND chip price "softening" beat down the stock into submission.
Effectively, legacy companies become sell the rallies type of stocks.
Transforming a legacy company into a high-octane cloud company is perilous to say the least. Jeff Bezos recently gloated that Amazon Web Service's (AWS) seven-year head start is all investors need to know about the cloud. There is some merit to his statement.
Examples are rife with bad executive decisions by legacy companies such as HP Inc. (HPQ), another legacy tech company that makes computers and hardware. It ventured out to buy Palm for $1.2 billion plus debt after a bidding war with legacy competitor Dell in 2010.
In 1996, the Palm PDA (Personal Digital Assistant) was the first smart phone on the market that predated BlackBerry's smart phone with the full keyboard made by RIM (Research in Motion).
The demise of Palm emerged from a hodgepodge of mismanagement, failed spin-offs, misplaced mergers, and resource wastefulness even with the preeminent technology of its time.
(HPQ)'s stab at the smartphone market resulted in purchasing Palm. However, after heavy selling pressure in its shares, HP shut down this division and sold off the remaining technology to Chinese electronics company TCL Corporation.
The sad truth is many transformations fail at step one, and there is no guarantee a newly absorbed business will perform as expected.
RIM, now changed to BlackBerry (BB), soon found out how it felt to be Palm when Steve Jobs dropped the first iPhone on the market, and the world has never been the same.
(BB) gradually morphed into an autonomous vehicle technology company after the writing was on the wall.
The other types of losers are companies with inferior business models such as Snapchat (SNAP), which I have written about extensively from the bearish side.
In an age where disruptors are being disrupted by other disruptors, CEOs must live in fear that their business will get undercut and hijacked at any time.
Instagram, a subsidiary of Facebook (FB), has permanently borrowed numerous features from Snapchat. Its Instagram "stories" feature is now used by more than 300 million daily users.
Snapchat is serving as Instagram's guinea pig while CEO Evan Spiegel finds an alternative way to survive against Facebook's unlimited resources.
Both are in the game of selling ads and nobody does it better than Facebook and Alphabet or has the degree of scale.
The recent redesign was met with a chorus of universal boos. The 60 minutes I spent testing the new design reconfirmed my fears that the new design was an unmitigated washout.
In short, Snap's redesign seemed like a different app and became incredibly difficult to use.
Compounding the deteriorating situation, Snapchat laid off 120 engineers due to sub-par performance and withheld last year's performance bonuses even though co-founder Evan Spiegel received $637 million in 2017.
The latest earnings report was a catastrophe.
Daily active user (DAU) growth, the most sought out metric for Snapchat, failed to deliver the goods. The street expected 194.2 million DAU and Snap reported 191 million. A miss of 3.2 million users and a deceleration of growth QOQ.
Remember that Snapchat is substantially smaller than Instagram and should have no problems surpassing expectations on a smaller scale, thus investors voted with their feet and bailed on the stock after the catatonic performance last quarter.
Instagram is six times larger with more than 800 million users as of the end of 2017.
Top line fell short of expectations and average revenue per user (ARPU) dropped to $1.21, far less than the expected $1.27.
The less than stellar redesign faced a rebellion from long-term Snapchat disciples. More than 1.2 million Snap diehards signed a petition hoping to revert back to the old interface, and its updated ratings in Apple's app store has fallen to 1.6 stars out of 5.
Then the perpetual question of why would advertisers want to pay for Snapchat digital ads when they earn more by buying Instagram ads?
This remains unsolved and appears unsolvable.
Snapchat is befuddled by the pecking order and the company is on a train to nowhere.
To hammer the nail in the coffin, Snapchat announced to investors that it expects revenue to "decelerate substantially" next quarter.
In an era where technology companies will lead the economy and stock market, and has an outsized influence in politics and culture, not all tech companies are one-foot tap-ins.
Investors need to separate the wheat from the chaff or risk losing their shirt.
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Quote of the Day
"We have to stop optimizing for programmers and start optimizing for users." - said American software developer Jeff Atwood
Mad Hedge Technology Letter
March 29, 2018
Fiat Lux
Featured Trade:
(TECHNOLOGY'S UPSIDE IN THE TRADE WAR)
(RHT), (DBX), (SPOTIFY)
After watching the performance of technology stocks over the past two weeks, you may be on the verge of slitting your wrist, overdosing on drugs, and then jumping off the Golden Gate Bridge.
However, the results reported by tech companies this week say you should be doing otherwise.
As tech companies confront upcoming regulation and an overseas trade war, it has felt like a death by a thousand cuts.
It almost is starting to feel as if being a technology company is akin to drinking from a poisoned chalice.
I beg to differ.
I will tell you why the destiny of tech is quite positive.
The long-term secular growth drivers will prevail of accelerated earnings amid a backdrop of global economic synchronized expansion.
Assiduous capital reallocation programs will attract investors instead of detract from them.
The ironic angle to the precarious diplomatic tumult is that regulation will ultimately benefit the current pacesetters and culprits of technology because the barriers of entry become insurmountable.
The trade war has the same effect as the data regulation because it is ultimately for the betterment and protection of domestic, made-in-USA technology.
Washington knows the FANGs all too well, and the bull market will cease to exist if Beijing buys out our technological expertise.
Short-term pain for long-term gain. That's it in a nutshell.
The White House further understands that it's better to start a trade war now when it holds a stronger hand. No doubt after 20 more years of an ascending China, the Middle Kingdom will leverage its economic clout for diplomatic power dictating the outcome more ruthlessly.
Effectively, Trump's trade fracas is a one step back and two steps forward policy. During the one step back phase simply seems as if the economy is taking a nosedive into the ocean floor.
Love it or hate it, technology is becoming more (and not less) ubiquitous. However, it's gone too far too fast, and society and public officials require time to absorb the new environment or you risk the current backlash.
Simultaneously, America is in the one step back phase of data regulation, trade laws, and society's backlash of encroaching tech.
Bad timing.
The teething problems will gradually subside, the stock market will re-ignite, and tech will advance further into regular life.
The market even has seen some green shoots with the blockbuster Dropbox (DBX) IPO up over 40% intraday on the first day of trading.
In the S-1 filing required for IPOs, (DBX) stated that it may "not be able to achieve or maintain profitability" because of increasing expenses. The disclosure also prefaced its "history of net losses" to justify the business direction.
(DBX) lost $111.7 million in 2017, on revenues of just over $1 billion.
Technology must be doing something right if loss-making firms are treated with a 40% gain on IPO day; and, Spotify, an even bigger money loser, will go public next week.
If investors are smitten with loss-making tech companies, I imagine they feel quite comfortable with the ones earning billions in quarterly profits and growing at a pace where analysts cannot hike their price targets quick enough, making them look foolish.
The outstanding gains by (DBX) was for one reason and one reason only.
It's a pure cloud play, and pure cloud plays have been rewarded in spades.
Red Hat's (RHT) stellar earnings were on the heels of the (DBX) IPO success.
Red Hat is a medium-size unadulterated cloud play that lacks the financial resources of the FANGs but is still turning a profit.
It is the poster boy for enterprise cloud companies flourishing in an unrelenting fierce environment.
If the world is going to hell in a handbasket, then how did Red Hat achieve aggregate billings growth of 25%?
Everyone and their uncle expect tech companies to start floundering, but the opposite is true. They overpromise then over deliver to the upside every quarter.
Red Hat booked the most deals over $1 million in Q4 2017 in its history.
Cross-selling cloud applications was especially strong with 81% of deals over $1 million spending on multiple software services.
The critical subscription revenue comprised 88% of Q4 revenue and is up 15% YOY. Application development-related subscriptions were up 42% YOY, higher than the infrastructure-related subscription revenue growing 17% YOY.
Companies are churning out innovation on top of their existing platforms using various software solutions. And every company in the world is migrating toward cloud software and infrastructure. There has never been a better time to be a pure cloud company.
The most poignant telltale sign was that Red Hat renewed 99 out of 100 of its top deals and disclosed that multiyear deals were healthy.
Ansible, its software for automating data center operations, OpenShift, its software for container-based deployment and management, and OpenStack, an infrastructure-as-a-service (IaaS) for cloud computing are the underpinnings to Red Hat's supreme business.
The reoccurring revenue salted away is legion.
The FY 2018 guidance was even more impressive than the quarterly earnings report. Red Hat expects a revenue range between $800 million and $810 million, up from the $748 million last quarter and expects quarterly EPS at $0.81, up from $0.70 last quarter.
Toward the end of the earnings call, Red Hat CEO Jim Whitehurst described the cloud growth environment as "very, very, very fast growth."
Market conditions and heightened volatility could stay irrational for longer than expected but leadership stocks are always the last to fall.
If (DBX) can catch a bid, and headway is made on political issues, then jump back into the cloud names that perform like Red Hat and about which I have been beating the drum.
And don't forget that these regulatory and political hindrances all point toward giving big cap tech cozier conditions and an elevated runway from which to operate.
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Quote of the Day
"We know where you are. We know where you've been. We can more or less know what you're thinking about." - said Eric Schmidt in 2010, the former executive chairman of Google from 2001-2017
